Commentary: You get what you pay for

The cat fight between the Panama Canal Authority (ACP) and a construction consortium over who is responsible for excess costs associated with building a new set of locks to increase the waterway’s vessel capacity was predictable.
Grupo Unidos por el Canal — led by Spanish construction firm Sacyr Vallehermoso, Italian engineering firm Salini Impregilo, Belgian dredging company Jan de Nul Group and Panamanian construction firm CUSA — won the $3.2 billion fixed-price contract in 2009 with a bid widely believed to have been considerably below that of its main competitors and below the $3.48 billion benchmark set by the canal administration.
The ACP followed rigorous technical standards in its selection process, but it appears to have dropped the ball when it came to analyzing the financial strength of the bid teams. Some industry insiders questioned the ability of Sacyr to do the job because of the company’s financial troubles, which were tied to the crash of the Spanish housing and construction market six years ago. Sacyr, like other big Spanish construction firms, jumped at the easy credit available from banks wanting to cash in on rising property values and building projects. It took on a huge amount of debt to diversify and launch raids on banks and other companies outside its sector.
One of its big bets was acquiring a 20 percent stake in Spain’s largest oil company, Respol. When Respol’s shares cratered, Sacyr suffered heavy losses at the same time the construction industry went into a tailspin. Eventually, Sacyr lost 90 percent of its value.
By the summer of 2011, Sacyr had $11 billion euros of debt and only 572 million euros in earnings before interest, taxes, depreciation and amortization, according to the Financial Times.
“In the past Sacyr often appeared like a black box to outsiders, with few analysts bothering to cover its shares, and its reluctance to communicate to the press giving it a reputation as a shadowy and arrogant company,” the FT said in a Feb. 19, 2012 story.
Confidential sources on engineering teams that pursued the bid for the locks project in 2009 confided to me at the time that the ACP’s terms were quite onerous, and consortia were pressured to submit bids without much negotiation on the terms. The proposed contracts didn’t allow much room for cost escalation and forced the contractors to take most of the risk even though the full design for the project had not yet been completed.
Another concern was the requirement that contractors buy large bid bonds designed to guarantee their ability to finish a job as spelled out in the contract. The bid bond provides assurance to the project owner that a contractor is financially stable or has the resources to take on a project. If the project fails, the owner can collect compensation from the surety bond.
Some teams decided not to place final bids because of the contractual terms.
Now, GUPC is seeking $1.6 billion in reimbursements for cost overruns it says were out of its control. One proposal from Impregilo is for the ACP to immediately pay the group $1 billion and then repackage and refinance previous cash advances for $500 million while an arbiter decides how to handle the difference.
The ACP should have realized that Sacyr was willing to do anything to win the contract and it would try to make money on the backend by raising prices when it had leverage. Turning to another contractor, at this point, could significantly delay the expansion project and increase its cost.
On the other hand, the ACP probably would have had political difficulty explaining to the people that it agreed to accept a more expensive bid if GUPC met all technical specifications.
One thing is clear. The ACP will end up paying much more for the entire canal expansion than the $5.2 billion it budgeted. The price tag could easily exceed $6 billion. But the ACP has the money. It has a contingency account for overruns built into its project plan. GUPC is simply going after a pot of money it knows exists.
Whether that will influence future toll rates currently being deliberated by the ACP board remains to be seen, but the ACP is smart enough not to price itself out of the market. At the end of the day, the toll structure will be set in accordance with the price-sensitive maritime industry, especially container lines that might decide delivering cargo to the U.S. East Coast is more economical via the Suez Canal or via transcontinental intermodal service from West Coast ports.